The pace of technological change seems to increase as the years go by. Think about the smartphone, the iPad, 3-D printing, and even the internet. Now we can add artificial intelligence to the growing list of disruptive technologies that are changing the way we live and work. Artificial intelligence can be defined as a computer system that can learn to perform tasks by using a reasoning capability similar to the human brain. Work has been going on in the field for several decades, but progress seemed to reach a tipping point earlier this year when Microsoft announced it was using ChatGPT in its search engine. Since then, there has been a rush to incorporate this technology into many areas of everyday life.
The text below came from an AI program when I asked for a market update:
The first half of 2023 has been marked by resilience and optimism in the global stock markets. Despite various challenges and uncertainties, equities have shown remarkable strength, buoyed by economic recovery, technological advancements, and accommodative monetary policies. This market update provides a comprehensive overview of stock market performance, key factors driving the markets, and notable trends observed through June.
Although the text is somewhat lacking in detail, it was generated in less than ten seconds with minimal prompts from me. Though we don’t know yet all the implications of this new technology, it’s certain that the effects will be far reaching. Schools are already having to respond to the challenges posed by AI as students can ask computers to write their term papers.
Investor interest in this burgeoning technology pushed the technology and related sectors into the winners’ circle for the first half of the year. The other eight sectors were essentially flat as a group, so it’s clear where all the investor interest was in the first half of the year.
Any index with a sufficient allocation to technology posted strong returns for the first half of the year. That certainly included the S&P 500 Index, which is 30% invested in technology. On top of that, it is a so-called “capitalization weighted” index, which means that the largest companies have the highest weighting in the index. As a result, companies such as Apple, Google, Meta (Facebook), and Amazon dominate the returns of the index. If they are doing well, they can pull up the returns of the index with them, even though they represent just four companies in an index of 500 names.
Indexes with a more modest allocation to technology, such as the Dow Jones Industrial Average or the equal-weight S&P 500 Index, delivered returns less than half what was posted by the S&P 500 Index.
Nevertheless, since the S&P broke out of its nine-month trading range in early June, we have been moving all the portfolios into a more fully invested position. For the most part, we have concentrated those purchases on a variety of large-cap, domestic funds as this area is showing the greatest relative strength. The table below shows the broad allocations of our seven active strategies:
The bond market continues to languish under the pressure of ongoing interest rate hikes by the Federal Reserve. We still believe there are good opportunities in the fixed income world, but we will have to wait until the second half of the year to see if that opportunity comes to pass.
Thoughts on the Second Half of the Year
Historically speaking, a strong first half of a year generally leads to a decent second half (with the Crash of 1987 being a notable exception). That is even more true after a down year for stocks. So, this bodes well for a continuation of the current stock market uptrend in the second half.
The one major yellow flag waving at us is the narrowness of the current rally, which I alluded to above. A market rally is healthier when a large number of stocks are participating, in particular when the smaller names are performing in line or even better than the large multinational companies. We are just not seeing that this year.
One of two outcomes will occur in the second half of the year. Either the rally will broaden out as smaller companies and the value segments of the market (financials, energy, etc.) lead the rally, or the current tech leaders will get pulled down into a correction that will clear the decks for a new rally. Could this narrow rally continue for a while longer? Of course, technology and internet stocks led the way for two years until the bubble burst early in 2000.
Meanwhile, the era of AI is just beginning, and it is hard to forecast how this technology will change our lives. As long as investor interest keeps pushing stocks involved in AI higher, we will participate through the various mutual funds and exchange traded funds (ETFs) that we own. When those trends reverse, you can rest assured that we will be keeping a close eye on the FSA Safety Nets® and exit any and all funds that violate those price levels.
In closing, we’ll let ChatGPT have the final words:
As we conclude the first half of 2023, the stock market has showcased resilience and optimism despite challenges and uncertainties. Economic recovery, technological advancements, and accommodative monetary policies have been key drivers of the market's performance. While concerns surrounding inflation and geopolitical factors remain, the overall market sentiment remains positive. Investors should continue to monitor economic indicators, corporate earnings, and evolving geopolitical landscapes to make informed investment decisions as we move into the second half of the year.
Portfolio Update
Keep in mind that because we manage clients’ portfolios individually, the holdings in your specific accounts may differ somewhat from the averages.
Strategies That Employ the FSA Safety Net®
Income (Strategy 1)
Since a nice bounce in January, bonds of most types have languished. The Income portfolios hold an eclectic mix of multi-sector, mortgage, and even pure treasury funds. Frankly, just holding money market funds would have matched what most bond funds were able to muster in the first half of the year. Currently, these portfolios hold 80% in bond funds and 20% in money markets.
Income & Growth (Strategy 2)
These portfolios have recouped about half of the modest losses suffered last year as we moved the equity allocation to its maximum of 50% in late June. In addition, 30% is allocated to a mix of bond funds with 20% in money markets funds.
Conservative Growth (Strategy 3)
We moved this strategy to its maximum equity allocation of 75% in June, even though we currently have no allocation to bonds. We are waiting for either high yield bonds or high-quality bonds to break out of their trading ranges before shifting away from the money market allocation, which is now yielding almost 5%.
Core Equity (Strategy 4)
The Core Equity portfolios now hold 90% in equities, tilted towards large-cap U.S. stocks. They also hold 15% in foreign stocks, which have languished since mid-May. This strategy continues to hold a technology sector fund given its strong performance this year.
Tactical Growth (Strategy 5)
Portfolios in this aggressive strategy are now fully invested, primarily in large-cap U.S. funds, including 20% in technology funds. We have the international fund on “watch” to pare back as its relative strength to the S&P 500 Index is waning.
Strategies WITHOUT the FSA Safety Net®
Sector Rotation
Sector Rotation accounts have recouped about half of what they lost last year. For June and July, the portfolios have held nearly half in technology stocks. As of the July rotation, in addition to the three technology funds, the portfolios hold financials, industrials, and transportation.
Global Rotation
After two difficult years, this is currently the best performing of our nine strategies. During the quarter, we sold one of the international funds, with half of the portfolios allocated to technology-heavy large-cap growth funds. This strategy has been fully invested since May.
Strategies That Remain Fully Invested Through ALL Market Cycles
Global Moderate
Even though these diversified portfolios posted solid results for the first half of the year, it’s clear that their performance was hindered by their allocations to real estate, gold, and bonds.
Global Growth
This aggressive strategy also showed strong results even though its allocation to real estate, gold, and emerging markets weakened returns.
Please remember to inform your advisor of any changes in your life that might affect your investment objectives and how we manage your money.
Ronald Rough, CFA
Chief Investment Officer
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